60-second revision
- BoP has two main parts: the current account (goods, services, income, transfers) and the capital/financial account (FDI, FPI, loans, banking capital).
- Remittances are current-account transfers; India has long been among the world's largest recipients.
- Rupee: devalued in July 1991, dual rate under LERMS (1992), market-determined unified rate from March 1993.
- Current-account convertibility since August 1994 (IMF Article VIII); capital account only partly convertible.
- FEMA, 1999 (in force 2000) replaced FERA, 1973; violations are civil, not criminal.
- FDI = 10% or more of a listed company's equity; below 10% = FPI.
- Forex reserves = foreign currency assets (largest) + gold + SDRs + reserve tranche position in the IMF.
- Foreign Trade Policy 2023 is open-ended; DGFT administers it; DGTR recommends anti-dumping duties.
Balance of payments
The balance of payments (BoP) records all economic transactions between residents of a country and the rest of the world over a period. Every transaction has two sides, so the BoP as a whole always balances; what analysts watch is the balance on its individual accounts.
| Account | Main items | India's usual pattern |
|---|---|---|
| Current account: merchandise | Exports and imports of goods | Large trade deficit (oil, gold, electronics imports) |
| Current account: invisibles | Services (software, travel, transport), primary income (interest, profits), secondary income (remittances, gifts) | Big surplus from software services and remittances |
| Capital / financial account | FDI, portfolio investment, external commercial borrowings, NRI deposits, banking capital | Usually a surplus that finances the current account deficit |
| Errors and omissions | Statistical discrepancy | Small |
| Change in reserves | Rise or fall in forex reserves | Absorbs the overall surplus or deficit |
'Twin deficits' refers to a fiscal deficit and a current account deficit occurring together. A large CAD financed by volatile portfolio flows leaves a country exposed if investors pull out suddenly, as India saw in the 1991 crisis.
Exchange rates
- Fixed (pegged) rate: set by the authorities. A deliberate reduction in an official rate is devaluation; an increase is revaluation.
- Floating rate: set by demand and supply in the market. A market-driven fall in value is depreciation; a rise is appreciation.
- Managed float: market-determined, but the central bank intervenes to smooth volatility. India follows this; the RBI buys or sells dollars from its reserves.
- India's path: devaluation in July 1991, the Liberalised Exchange Rate Management System (dual rates) in 1992, and a unified market-determined rate from March 1993.
A depreciating rupee makes Indian exports cheaper abroad and imports dearer at home, which can widen inflation through imported oil and inputs. It also raises the rupee cost of servicing foreign-currency debt. Nominal effective exchange rate (NEER) measures the rupee against a basket of currencies; the real effective exchange rate (REER) also adjusts for relative inflation.
Convertibility
Convertibility means the freedom to convert rupees into foreign currency and back. The rupee has been fully convertible on the current account (trade, travel, remittances) since August 1994, when India accepted Article VIII of the IMF's Articles of Agreement. Capital account convertibility (moving capital freely in and out) remains partial and calibrated; the Tarapore Committees (1997 and 2006) laid out preconditions such as low fiscal deficits and inflation and a sound banking system. The Liberalised Remittance Scheme lets a resident individual send up to USD 2,50,000 abroad per financial year for permitted purposes.
Foreign investment
| Feature | FDI | FPI |
|---|---|---|
| Threshold | 10% or more of equity of a listed company | Below 10% |
| Motive | Lasting interest and control | Financial return |
| Stability | Long-term, brings technology and management | Can exit quickly ('hot money') |
| Routes | Automatic route or government route | Through stock and bond markets |
Other external borrowing channels include External Commercial Borrowings (loans raised abroad by Indian firms) and masala bonds, which are rupee-denominated bonds issued outside India so that the foreign investor bears the currency risk.
Forex reserves
The RBI manages India's foreign exchange reserves, which have four components: foreign currency assets (the bulk, held mostly in government securities of major economies and deposits), gold, Special Drawing Rights allotted by the IMF, and the reserve tranche position (India's own quota-linked claim on the IMF that can be drawn without conditions). Reserves are judged by import cover (months of imports they can pay for) and by their ratio to short-term external debt.
Laws, policy and institutions
- FEMA, 1999 (in force from 1 June 2000) replaced FERA, 1973. FERA aimed to conserve scarce foreign exchange and treated violations as criminal; FEMA aims to facilitate trade and payments and treats violations as civil.
- Foreign Trade Policy 2023, in force from 1 April 2023, has no fixed end date, unlike earlier five-year policies. It is administered by the Directorate General of Foreign Trade (DGFT).
- Special Economic Zones are governed by the SEZ Act, 2005; Export Oriented Units are a separate scheme.
- Trade remedies: the Directorate General of Trade Remedies (DGTR) investigates dumping, subsidised imports and import surges and recommends anti-dumping duties, countervailing duties or safeguard measures; the Finance Ministry imposes them.
Terms of trade
Terms of trade = (index of export prices / index of import prices) x 100. If the index rises, each unit of exports buys more imports, an improvement. For India, a fall in global crude oil prices tends to improve the terms of trade because oil is a big import.
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